Comment: Internet Bankings Early Movers Get Mauled on Street

Among the rationales offered for investing in emerging Internet banking technologies is the proposition that first movers and early adopters gain an advantage over less agile competitors.

Dont believe it.

A cursory examination of the now-separate parts of what started in 1996 as the Internet pioneer Security First Network Bank is instructive. The software arm became S1 Corp., while the bank itself was acquired by Royal Bank of Canada in 1998.

First, lets consider the bank. Its first-mover status has produced the following performance results: As of June 30, has produced a 6.23% loss on assets and a 30.43% loss on Royals equity. As for operating efficiency, Security First spent $685.51 to generate each $100 of revenue  a number that would be almost laughable if the earnings implications were not so serious.

In short, the bank is still extremely unprofitable.

Second, lets assess what the now-unrelated software company has accomplished for its shareholders. S1 generated a loss of $346.3 million for the first nine months of the year. Its balance sheet shows negative retained earnings of $572 million, an amount equal to roughly 36% of what the shareholders paid in capital.

S1s common stock has fallen from just over $77 a share at the beginning of the year to a Dec. 20 close of $5.9375, a decline of 92.2%, or about three times the Nasdaqs loss in the same period.

Do these losses suggest a short-term problem for S1? Hardly. Next years consensus earnings forecast of 17 analysts that follow this company is that S1s losses will again be north of $400 million.

So what about other Internet banking first movers? We are still waiting for one with recurring profits from ongoing operations (as opposed to one-time, extraordinary gains).

What did Edify and nFront get for their early entry? They were purchased by competitors and paid with stock with ever-declining market value from money-losing ventures.

What has happened to the market capitalization of the early Internet-only banks USABancshares.com and NetBank? Both are trading at substantial discounts to shareholder equity.

What has Chase Manhattan Corp. earned for its quick movement to bankroll emerging Internet companies? After early rewards, depressed values in those investments have hammered the institutions results for last two quarters.

How are the Internet-only lenders E-Loan, LendingTree, and Mortgage.com doing? The first two are manifestly unprofitable, and their stocks are trading at a fraction of their IPO prices. The third has padlocked the doors after blowing through $60 million.

How long should first movers wait for results? CheckFree Corp. is the acknowledged leader in the bill payment arena. It has been exploring the various developments related to this opportunity since the early 1980s. Despite this unarguable initiative, it lost roughly $76 million (before a tax credit) in the third quarter. CheckFree has accumulated net losses of $384 million.

For bankers, it is wise to take a conservative attitude about technological innovation, especially when customers are involved. Early system releases are never remotely complete and never fully evolved.

Another reason for wise deliberation is the front-end costs of introducing new products or services. Educating staff and raising consumer awareness are costly exercises. First movers bear a disproportionate amount of the burden.

Given the diminished levels of customer and staff loyalty engendered by years of disruptive industry restructuring, this is an expense worth avoiding, since little lasting benefit is likely.

Bankers, so often lampooned for technical stodginess, can find better uses for their investment dollars than untried and unproven technologies. So far the only certainty in the world of Internet banking is that large losses can be incurred in very short order.

Mr. McGrath is a managing partner at Bank Earnings International LLP, a consulting firm in Orange, Va.

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